As discussion of the details of the Solvency II regime rolls on, insurers are thinking long and hard about how they will manage and monitor their risk strategies and capital bases. But the implications of their decisions will reach far beyond the boardroom, affecting both their relationships with corporate and individual policyholders, and also their role as major investors in the debt and equity capital markets.

The new regulations were designed to ensure better protection for policyholders, but raise important questions about the extent to which consumers and corporates will ultimately foot the bill for Solvency II, either directly through higher costs or indirectly via less comprehensive products.

Meanwhile, the demands of the new regime threaten to disrupt the key role played by insurers as investors in the capital markets, by pushing them towards ‘safer’ assets with lower capital charges, and away from the equities and non-investment grade debt on which much private industry depends for financing. This could be a particularly troubling outcome for businesses seeking to raise capital, given that banks remain reluctant to lend because of their own balance sheet constraints.  

The Economist Intelligence Unit, on behalf of BNY Mellon, conducted a survey of 254 EU-based companies, including insurers, other financial institutions (FIs, excluding insurers) and corporates (non-financial institutions, or non-FIs). The findings shed light, from a broad range of perspectives, on the potential impact of Solvency II on the retail consumer, the insurance industry itself and industry more broadly, including how insurers are likely to behave as debt and equity investors.

Key findings include:

• Solvency II goes too far in its requirements

Survey respondents believe that Solvency II oversteps the mark, with only 16% agreeing that it strikes the right balance in ensuring insurers have sufficient capital to meet their guarantees. Insurers and FIs (excluding insurers) are more critical of Solvency II, with 55% believing the directive goes too far compared with 39% of corporates (non-FIs). Less than one in five insurance respondents believe that most insurers are insufficiently capitalised under the present regime.

• Policyholders will ultimately bear the costs

Almost three-quarters (73%) of survey respondents agree that the costs to insurers of compliance with the new regulations will be passed on to policyholders, and there is concern that both corporates and individuals may choose to be under-insured as a consequence. However, insurers are markedly less convinced (57%) than FIs (excluding insurers) (82%) and corporates (non-FIs) (69%) that policyholders will pick up the tab, raising the question of how they see the costs of regime change being met. Also, over one-half (51%) of respondents believe the shift to unit-linked policies, which put the investment risk on the policyholder, will have a negative long-term affect on pension and long-term savings provision, with life insurance and annuities considered the products most likely to be affected.

• Insurers expect to further de-risk their asset allocations

A clear shift down the risk spectrum is anticipated by respondents. Assets expected to attract more interest include investment-grade corporate bonds, cash and short-dated debt, at the expense of non-investment-grade bonds, equities and long-dated debt. Almost three in five (58%) respondents overall believe that shift will happen gradually, giving time for market adjustment. But nearly one-third of corporates (non-FIs) (32%) do not believe the changes will have an adverse impact on any asset class, suggesting they may not fully understand the wider financial implications of the new regime.

• Corporates seem less aware of the impact Solvency II will have on debt issuance

Among insurers and FIs (excluding insurers) there is a strong consensus that Solvency II will make the tenor and rating of bonds from corporate issuers more significant, as insurers, driven by capital charge considerations, are increasingly pushed towards investment-grade debt. However, corporates (non-FIs) seem less aware of this shift, with just 48% agreeing compared with 62% of insurers and 79% of FIs (excluding insurers). The reality is that companies are likely to have to either adjust their capital structure to achieve investment-grade status or offer higher yields in compensation for the capital cost to insurers.

• Regulators should revisit their capital charge levels

Given the economic risks attached to many EU countries at present, there is strong support, particularly among insurers (50%), for regulators to reassess the zero capital charge for sovereign bonds—despite the fact that a readjustment would mean they would be required to hold further capital. A further 41% of insurers would like to see the capital charges for all assets reconsidered. Overall, less than one-quarter (22%) of respondents believe that regulators should maintain the current capital charges.

• Is Solvency II creating a ‘squeezed middle’ among insurers?

While large insurers are able to absorb the costs of preparation for Solvency II and enjoy the benefits of economies of scale, and the small, local or specialist providers prevalent in continental Europe may either fall outside the scope of Solvency II altogether or have a sufficiently strong niche market to survive and thrive, the mid-sized mutual insurers could be at a disadvantage. Only 16% of respondents expect no material impact from Solvency II on the structure of smaller friendlies and mutuals, and more than one-half (54%) believe the pressures of the new regime will result in a spate of consolidations to achieve scale, while 36% of insurers believe these players will outsource more in order to access scale.